Mizuho's Merrill deal a new turn for Japan banks

By IBT Staff Reporter On 01/22/08 AT 11:42 AM

Mizuho Financial Group's $1.2 billion investment in Merrill Lynch marks a turning point for Japan's once-reeling banks which, after shedding bad debt and rebuilding their businesses, are once again looking for opportunities abroad.

Last week's deal, the first major investment by a Japanese bank in a Wall Street firm since 1989, would have been unthinkable just five years ago, when Tokyo's stumbling lenders symbolised nearly everything wrong with the world's No.2 economy.

But thanks to relatively small exposure to subprime investments, the likes of Mizuho, Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group are now in better shape than some of their bigger U.S. rivals such as Citigroup.

With ample access to funds and facing limited growth opportunities at home, Japan's major banks are likely to be looking at bank stakes and assets in Asia and beyond, analysts say.

How the times have changed. It's a mere five years since Merrill was investing in Mizuho, said David Threadgold, banking analyst at Fox-Pitt, Kelton in Tokyo.

(Japanese banks) have not taken, relative to their size, any material hits and seem unlikely to take any material hits from subprime losses, Threadgold said.

Japanese banks have largely shied away from riskier investments since teetering on the brink of collapse several years ago, when they eventually required a massive injection of public funds to stay afloat.

Mizuho, for instance, has about $7.4 billion invested in products related to residential mortgage-backed securities (RMBS) with $982 million of that exposed to riskier subprime mortgages.

Last week, Merrill reported about $16 billion in mortgage related write-downs and adjustments for the fourth quarter, marking the worst quarter in its history.

Mitsubishi UFJ, Japan's largest bank, likely lost as much as $470 million on subprime investments last year, industry executives with direct knowledge of the matter said last week.

While that would be more than a tenfold increase on its previous estimate, it is just a sliver of the losses taken at Citigroup.

The U.S. bank last week booked a record $9.8 billion quarterly loss due to mortgage write-downs, and said it plans to raise $14.5 billion to shore up its finances.

STRAIGHT INVESTMENT

Analysts and investors said the Merrill deal, while symbolic, was likely more of a straight financial investment for Mizuho, rather than the first step toward a comprehensive alliance with Merrill.

The Japanese lender, together with Kuwaiti and Korean sovereign funds, will receive convertible preferred shares in Merrill which pay an annual dividend with a 9 percent yield, or a 9 percent premium on the share price.

The meaning is the investment value, the 9 percent yield on the preferred shares, said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.

It's difficult to imagine a tie-up between the two, Ogawa said, citing the difference in business models between the two firms.

LOOKING ABROAD

The deal comes as Japanese banks have become more vocal about expanding abroad.

The incoming president of Mitsubishi UFJ's core banking unit told a news conference last week that overseas acquisitions or alliances would be necessary to boost profitability.

We will eventually have to take a non-organic (growth) strategy, said Katsunori Nagayasu, who will take the helm of Bank of Tokyo-Mitsubishi UFJ in April 1.

The head of Sumitomo Mitsui told Reuters earlier this month that Japan's third-largest bank would consider buying assets of a Western bank, if the acquisition would complement its growth strategy.

Domestic media reports have said Sumitomo Mitsui is likely to start a capital tie-up with Malaysia's RHB Capital, although the bank has declined to comment.

The one thing (Japanese banks) have which is becoming clear that's a strength in this world is they have liquidity, said Graeme Knowd, banking analyst at CLSA Asia-Pacific Markets.

Are their better opportunities for them to lend abroad? Arguably, yes.

Even as lending opportunities still remain weak at home, Tokyo banks, infamous for their rigid business style and stubborn aversion to risk, are unlikely to make a mad dash overseas.

Japanese banks have been quite successful in facilitating trade finance and other offshore activities for Japan-based companies, and I think that will continue to remain the case, said Marc Desmidt, head of the portfolio management group of BlackRock in Tokyo.

Selectively I am sure they will look to gain either indirect or direct exposure to rapidly growing parts of the world, albeit in a very conservative manner.